The US Dollar is a Crowded Trade – Why this Matters for Gold

The US Dollar is a Crowded Trade – Why this Matters for Gold

In a recent report by Sprott Senior Portfolio Manager Trey Reik, he points out several reasons why gold remains not only an important portfolio diversification tool, but also an asset class ripe for a rebound. In his full length report, available here Trey notes that one of the reasons to look to gold is the current state of the US dollar: “U.S. dollar sentiment among western investors has become close to unanimously bullish.” We examine the impact of this on gold.

A strengthening dollar is good for American consumers. We are able to buy more goods at a lower price than the rest of the world. However, for American producers who export, a strengthening dollar means fewer international customers are able to buy our goods, and quantity demanded often declines in such an environment. That’s where Economics 101 ends and Trey begins.

Trey cites a CFTC chart that shows the combined net speculative long and short trades of the euro, the Yen, and the pound against the dollar.

Take a look at 2015. After a big jump throughout the first half of the year, there has been somewhat of a reversal, indicating that speculative traders would now rather have yen, euros or pounds than U.S. dollars. This is a signal that the US dollar has potentially already topped in value, relative to the currencies of other developed nations. But how does this relate to gold?

Trey’s chart shows the combined speculative demand for USD relative to other currencies. To show a bit more detail, we also broke out the different currencies, and marked the foreign exchange rates of the yen, the euro, and the Canadian dollar to zero as of January 1, 2010. While the above graph combines all CTFC (a.k.a. futures traders’ expectations), this chart shows the spot (actual) price movement of the currencies over the last four years. Gold is often considered a corollary currency, so we’ve added in the spot gold price (like the forex rates, gold is denominated in USD. The line is marked in red).

This chart illustrates not only the strengthening of the USD over the other currencies, but also gold’s resilience during an inflationary environment. While gold prices have certainly declined as the USD rises, it might be small comfort to see that gold loses less value than other currencies, it also appears to recover more quickly. This chart also shows that gold behaves like a currency, but one that is not easily manipulated by central bank policy. Gold mitigates some deflationary risks.

Trey speculates that the USD is as strong as it will get in this current market cycle, and we may be looking at the top of the market for the USD. Indeed, his next chart, titled “Net Foreign Purchases of Treasuries” demonstrates that foreign buyers are now net sellers of U.S. Treasuries (in reality, this is an indication that they have nothing left to sell, or that everything else that they hold is marked below cost. They don’t want to take a loss any more than you do!)

Please read Trey’s full report here. We examine four common recessionary indicators in our next educational article.

We hope you enjoy this series of educational posts which seek to explain the various technical indicators and their potential consequences on precious metal prices. Feel free to contact us to learn more – we would be happy to explain the central themes in greater detail.